HSBC’s overdone fears

HSBC has been in damage-control mode since its head of responsible investing stated that the climate change related threat has been exaggerated and its largest shareholder, the Chinese insurer Ping An asked the group to spin off its Asian business. The first fire will likely be easier to extinguish than the second one which corresponds to another development of the escalating confrontation between the US and China. This geopolitical issue largely explains the current valuation discount on the group’s share price in our view. In part because of potentially politically incorrect arguments, we believe that such a discount is undeserved.

An Asian trade finance bank with a Western passport

HSBC has its headquarters in London thanks to a symbolic UK presence in retail banking. In reality, the group remains principally a Hong Kong based financial institution involved in the financing of trade between the US and China. This should not come as a surprise as the bank was originally founded as a financial bridge between Asia and the West and located in Hong Kong which has become a fully-fledged US state from a monetary (pegged currency) or legal (British Common-Law) standpoint.

The revenue or balance sheet breakdown provide a false sense of diversification with Asia accounting for less of 50%. 

If one considers that the group’s non-UK Western operations, be it in CIB or Wealth Management, are related to its Asian presence, it appears that the Asia-Pacific region accounts for almost 85% of the group’s underlying profits. The remaining 15% largely corresponds to the UK retail banking business whose main purpose in our view consists in securing a Western citizenship.

The group has developed a presence in Mainland China as well as in the rest of Asia (notably in Singapore) and the Middle East (mostly in UAE) where it promotes its wealth management offer. However, the bulk of the Asian business remains developed from Hong Kong which still gathers 70% of the group’s Asian deposits.

Depressed valuation multiples

The stock trades at 8.7x one year forward EPS based on Bloomberg expectations. As shown in the chart below, this corresponds to a sharp 25% discount to previous highs. With no surprise, the discount corresponds to the upside potential based on the consensus’ average target price.

One year forward P/E

Source: Bloomberg

For those who prefer price to book value multiples, the stock trades below 0.7x whereas the group’s first quarter results enabled management to reiterate its above 10% RoTE guidance for 2023, in line with consensus expectations and the cost of equity.

Given the group’s Chinese bias, we suspect that the valuation discount reflects investors’ concerns on the potential implications of China’s apparently irrational zero-COVID strategy and above all, of the mounting tensions between the US and China.

We believe such concerns are largely misplaced.

Every pandemic comes to an end

China’s relentless zero-COVID strategy confirms that the technocratic irrationality does not affect only liberal societies. Fortunately, in spite of the Communist Party’s efforts, Chinese people will eventually get immunised against COVID, and the economy will recover, potentially boosted by the State’s support.

The end of Chimerica will not correspond to trade ending

The US seem to have finally made up their mind that China not only will not adopt their political model, but instead threatens their hegemony. As a result, they decided to stop fuelling China’s development by raising trade barriers in 2018 under the Trump’s administration.

Ukraine’s invasion has seemingly accelerated the bipolarisation of the world with the US requesting countries to choose their camp not only from a military standpoint (NATO’s extension in Europe and beyond) but also from an economic standpoint (as clearly expressed by Janet Yellen). In response, the opposite camp, formed around China, contemplates the development of equivalent alliances.

However, as past history or the Ukraine’s invasion show, wars and trade usually continue to coexist. As a result, if one excludes a World War III scenario, there is no reason to believe that HSBC’s main source of profits will disappear soon.

HSBC remains a useful asset for both camps

HSBC was embroiled in the geopolitical game between the US and China. Hence, the group was first forced to cooperate with the US authorities to frame Huawei. It was then requested by China to support the Hong Kong security law and to freeze the deposit accounts of pro-democracy leaders. The group successfully navigated this threatening test as it has done before during its long history. The announcement by Ping An, the Chinese insurer and HSBC’s largest shareholder, that it has raised its stake to 8% came as a confirmation that HSBC continues to be seen as a strategic asset.

However, more recently, Ping An (which is viewed as the Communist Party’s voice) met with HSBC’s management to request a spin-off and the listing of the group’s Asian activities, officially arguing that it would free hidden value. Importantly, such a meeting followed a meeting between the Chinese Central Bank and domestic and international banks to discuss solutions to protect China’s financial system against US retaliation measures similar to what has been imposed on Russia.

According to press articles, HSBC’s management is opposed to such a proposal. Although Ping An’s detailed project has not been disclosed, analysts made negative comments on the project as they understand that it has more to do with geopolitical tensions than with shareholder value creation. Former examples, such as that of SAN which promoted a listed subsidiary-based model over several years before abandoning it, confirm that value creation is not guaranteed. On the other hand, analysts are concerned about the potential costs and dis-synergies related to a spin-off. However, we believe that fears are overdone. Indeed, it is worth noting that the Asian operations are already performed through a fully-fledged subsidiary named Hong Kong and Shanghai Banking Corporation (HBAP). However, the subsidiary’s capital is provided by the holding company (HBAP issued only $400m Tier 2 debt in 1991). In our view, the aim of Chinese authorities, expressed through Ping An, is to secure HSBC’s Asian depositors ($550bn) against Western losses (potentially sparked by retaliation measures) with adequate capital. The listing of a portion of HBAP’s capital could be done easily in our view and without any operational impact. As the bulk of Western operations consist in already ringfenced UK banking activities, we consider that the risk of increased capital requirements at the group’s level evoked by analysts is limited. Based on our Sum of the Parts, the value of the Asian operations could represent at least 60% of the group’s total value.

China, big winner of Russia’s pivot towards Asia?

Even if it is too early to conclude, the latest news seems to confirm that Russia is well positioned to get Ukraine’s targeted territories whereas the economy and above all the financial system has not gone bankrupt. As a result, the US’s objective to provoke a regime change in Russia looks unlikely to be met in the foreseeable future, thus making a definitive pivot of Russia towards Asia more likely.

However, the US can claim some victory, having imposed a strong hit to Russia and secured its current geographical footprint by not only reviving but also extending NATO.

Although the big loser seems to be the EU, China seems to be the big winner of Russia’s pivot to Asia as it will enable it to meet its future needs in terms of natural resources and food at a competitive price.

HSBC, thanks to its leading Asian franchise and its presence in every financial hub across the world, could only benefit from the increasing wealth management needs of Chinese people.

Valuation: confirmed discount

Our Neutral recommendation is based on an apparently fairly valued stock. However, as shown in the table below, our weighted average target price is depressed by peer comparisons (but the peer group is unhelpful as it is made up of European peers) whereas the SOTP and the DCF-based Intrinsic Value return upside potentials consistent with the 25% valuation discount mentioned above. 

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